The shape of a firm's long-run average cost curve is determined by two primary factors: the returns to scale inherent in the production technology (increasing, decreasing, or constant), and how the scale of production affects the prices the firm pays for its inputs.

Google

Constant returns to scale describe a production scenario where increasing all inputs by a certain proportion results in an equivalent proportional increase in output. For instance, if all production inputs are doubled, the total output will also double. From a cost perspective, this production property implies that the firm's unit cost of production remains constant regardless of the output level. This concept influences the shape of a firm's long-run average cost curve, which depends on both returns to scale and how input prices are affected by the scale of production.

Constant Returns to Scale

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

A hypothetical olive oil production method illustrates a technology with two key characteristics: fixed proportions and constant returns to scale. In this example, producing 50 liters of oil daily requires a precise combination of three machines, one worker, and 80 kWh of energy. Due to its fixed-proportions nature, increasing a single input without proportionally increasing the others does not boost output. This technology also exhibits constant returns to scale: if all inputs are increased by the same percentage, output rises by that same percentage. For instance, doubling all inputs to six machines, two workers, and 160 kWh of energy doubles the daily output to 100 liters. Similarly, a 50% increase in all inputs results in a 50% increase in production.

Hypothetical Example of Olive Oil Production with Fixed Proportions and Constant Returns to Scale

The technology for modern olive oil production can be modeled by a production function with two primary inputs: labor (number of workers, $N$) and energy ($E$). This simplification is possible due to the assumption that capital and energy are used in fixed proportions. This specific production technology also exhibits constant returns to scale, meaning that if both labor and energy inputs are increased by a certain percentage, the output of olive oil increases by the same percentage. The model deliberately omits raw materials, assuming the required quantity of olives is determined by the production target.

Production Function for Olive Oil with Two Variable Inputs and Constant Returns to Scale

Factors Affecting the Long-Run Average Cost Curve

For the specific case of Apple Cinnamon Cheerios, it is assumed that the unit cost is \$2 per pound. This implies that for a quantity Q (in pounds), the total cost function can be modeled as a linear equation: $C(Q) = 2Q$. This model suggests a production process with no fixed costs and a constant marginal cost of \$2 per pound, which is characteristic of constant returns to scale.

Learn Before

Related